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Financial reporting - A time of change Back  
Accountancy faces a challenge like never before, writes Brendan Sheridan.
The world of accounting and financial reporting has never before confronted such significant challenges - challenges which will have a major impact on all Irish companies.

The developments we face pose major questions, namely:
• How do we restore credibility in the financial reporting process following alarm bells pressed by recent major accounting scandals - Enron, WorldCom and others?
• How will we manage the impending deluge of new standards and regulatory processes?
• How do we maintain awareness of the ongoing programme of convergence of accounting standards on a global basis?

Investors and the general public have a right to expect greater comparability and transparency of financial information. The business community is responsible for ensuring their needs are met.

What action is being taken?

The movement towards globalisation of accounting standards is best summed up in the comment of Sir David Tweedie, Chairman of the International Accounting Standards Board (IASB), that ‘the IASB’s objective is to move towards a single set of high quality global financial reporting standards ...that give investors confidence that published financial statements show a full and accurate picture of a company’s performance and position’.

A major step in the global convergence process has been the issue by the EU on 7 June 2002 of a regulation requiring adoption of International Accounting Standards (IAS) for the consolidated financial statements of listed companies from 2005. Over 7,000 listed EU companies are directly affected. Similar processes are being implemented in other regions and the adoption of IAS has been endorsed by major regulatory bodies on a global basis.

The US is critical to achieving global convergence. The Financial Accounting Standards Board (FASB) has committed to a programme of convergence of existing standards with IAS and maintaining compatibility of standards going forward.

Controversy in recent times has resulted in the FASB issuing draft proposals for a move towards principles-based accounting which is the approach favoured by both the IASB and the Accounting Standards Board (ASB), our current standard setters. The rule-book approach currently adopted is clearly seen by many as being less than acceptable.

What about Irish private companies?

The Irish Government is currently in the process of consultation on whether to permit or require all Irish companies to adopt IAS.

The prospect of different accounting standards for listed and unlisted entities is not attractive and defeats the core principle of improved comparability and transparency.

Considerable amendment may also be made to our legislation, applicable to financial reporting, in order to accommodate change.

In any event, IAS may be phased in by the ASB’s convergence programme, making it applicable to all Irish companies and starting in 2003. Big changes should be expected; changes that do not derive from operational activity; changes that will impact on profits and net assets of companies; and changes that may mean restated comparative financial statements for up to three years, and even after that.

Over the next couple of years new or revised standards are expected in a wide range of areas and the ASB has issued ten exposure drafts since May 2002.

OK - what is going to change?

Differences exist in such divergent areas as performance reporting, business combinations and the consolidation process, deferred taxes, pension accounting, investment property and many others. Additionally, there are a number of areas which require either new or revised standards or significant extension to our existing standards, notably in such areas as share-based payment and the many aspects of accounting for financial instruments.

Draft standards issued recently include those on share-based payment and business combinations, with drafts expected in 2003 in a number of areas including performance reporting and insurance accounting.

Significant issues on the standard-setting agenda include revenue recognition, asset impairment and accounting for special purpose entities. Full implementation of the controversial FRS 17 requirements for retirement benefits has also been deferred pending IASB review.

Already we have seen proposals on such matters as:
• Inclusion of a charge against profits in respect of share options granted to employees.
• Prohibition of merger accounting for business combinations.
• Prohibition of goodwill amortisation to be replaced by annual impairment reviews.

What impact will these changes have?

Changes in any one of the areas mentioned may impact on companies with the potential combined effect being significant for many.

Conversion exercises carried out on an approximated basis between currently adopted standards and IAS indicate that significant differences can arise, examples of which include:
• A financial institution showed reported profits falling by 35 per cent under IAS.
• A property group which would report 8 per cent higher profit under IAS.

Can companies afford to face into this unpredictability without investing resources into monitoring change and projecting the anticipated impact on reported earnings and financial position?

Will the financial services Industry be affected?

Matters of particular significance to the financial services industry include:

• The recognition and measurement of financial instruments dealt with in IAS 39 presents significant new accounting requirements and is currently under review with particular focus on extending the use of fair value accounting.
• IAS 39 also deals with hedge accounting, proposing that it should be used for financial instruments only if the hedge is pre-designated and meets certain effectiveness criteria.
• Insurance accounting - projects are currently taking place which are proposing significant changes to the manner in which insurance contracts are accounted for.
• A standard is imminent on disclosure and presentation in the financial statements of entities carrying out deposit-taking, lending and securities activities with proposals for enhanced disclosure of risk exposure capital adequacy information.

The company accountant can handle this!

The issues to be addressed are more than just an accounting exercise and involve a wide spectrum of management and commercial issues. Accounting teams should not confront this challenge alone.
The issues presented by the challenge of IAS convergence and implementation require attention to planning throughout organisations and support from the board and senior management during transition. Areas that may require attention include:
• Awareness of new and revised standards and their implications.
• Training and support requirements.
• Possible changes to systems, controls and reporting processes.
• Investor relations and keeping them informed of impact of significant accounting changes.
• Possible impact on management performance bonuses if underlying accounts are changing.
• Treasury and financing - key ratios for debt covenants may need amendment.
• Effectiveness of financial products may require review.

Most companies have good systems - this shouldn’t be a problem!

Transition to new and revised standards will require consideration of data collection and formulation requirements. Consider whether your system can easily change reporting formats, add additional data analyses, and roll out changes to meet the evolving reporting requirements over the coming years.
Should you need to change or significantly embellish current systems, remember that systems providers will face significant demand - early diagnosis of the issues involved is not an option - it is a must!
How up-to-date are accounting teams with current accounting standards and how well equipped are they to cope with change? Pressures brought to bear by operational matters limit the time available for such commitments. What are the training and support needs?

Transition - what do companies do now?

The first step in the process of scoping the impact of transition is identifying and quantifying the detailed differences which may affect a company’s business and carrying out conversion exercises from Irish/UK GAAP to IAS to evaluate the impact of any differences, including any under consideration in the ASB exposure drafts currently in issue.

Confronting the challenges as described will place significant demands on management resources and their ability to manage change. Those companies that plan and put in place a transition management process at an early stage will be at a clear advantage.

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